Plan Actuarial Equivalence

[Gary]

If a plan is to have lump sums as a benefit option, how low is a reasonable interest rate for determining the lump sum value? That is how low can the rate be and still not be disallowed by the IRS?

[Chester]

The interest rate can be as low as the plan sponsor desires. Section 417(e) serves as a floor for lump sums, but the ceiling is open. However, from a practical point of view, you would not want to set the interest rate too low, because the plan needs to be adequately funded in order to pay out lump sums, and the actuary is constrained by IRS regulations to the use of explicitly reasonable interest rate assumptions for the valuation of plan liabilities and costs. Therefore, if the actuary has been using a 7% interest rate for valuing plan costs, but the lump sum rate is 3%, the plan will end up paying out more in lump sums than the actuary was funding for, and the plan will eventually become underfunded.

[Gary]

Chester, thank you for your response. So, in other words, you can use a low interest rate as long as the IRS provides a favorable determination. I believe that it is reasonable to use the lump sum rate for post ret interest in the val., especially if most are expected to take lump sum.

[Guest Harry O]

The IRS regulations require that no optional form of benefit be more valuable than the QJSA. If you are using the mandated section 417(e) interest rate to value lump sums (30-year Treasury rates) its hard to see how the IRS can make a fuss that your lump sum is more valuable than your QJSA. If you use an interest rate lower than the 417(e) rate, you start to run the risk that the IRS will argue that your lump sum is the most valuable form of benefit. Something to think about . . .